THE NATION

Buyers losing grasp on affordability

July 31, 2005|By Ruth Simon, The Wall Street Journal

After dropping almost steadily for three years, an important measure of housing affordability has reversed course, a development that could help put the brakes on prices in some of the nation's hottest markets.

Some of the most powerful fuel helping to sustain the five-year housing boom has been the onslaught of creative mortgage products -- from interest-only loans to adjustable-rate mortgages carrying starter rates as low as 1 percent -- that have allowed buyers to keep initial payments down even as home prices have soared. As a result, the average initial monthly mortgage payment largely has declined since 2002, according to an analysis by Bear Stearns Cos.

But in a significant shift, those numbers reversed direction in the first quarter of this year. The average initial mortgage payment for home buyers climbed to $2,338 in the first quarter from $2,060 in the fourth quarter of 2004, according to the investment bank. The Bear Stearns analysis looked at jumbo mortgages, which are loans above $359,650.

That suggests many home buyers are likely to have an increasingly difficult time offsetting higher home prices by taking advantage of low interest rates and new mortgage products designed to lower their monthly payments. If this trend continues, some home buyers may have to stretch more or set their sights lower. Declining affordability also could help slow the torrid home-price appreciation in the nation's hottest home markets.

The decline in affordability in some markets is supported by other recent data. In 41 out of 325 metro areas nationwide, home prices were so high during the first quarter that someone earning the median income couldn't afford a median-priced home based on traditional lending standards, according to an analysis prepared for The Wall Street Journal by consulting firm Economy.com. In the fourth quarter, 29 metro areas were considered "unaffordable." Among the additions: Stockton, Calif., and Worcester, Mass.

Another telling note: In much of the country rising incomes aren't keeping pace with the hefty increases in home prices. Home-price appreciation outpaced income growth in 38 of the 50 states and the District of Columbia in the 12 months through March, according to an analysis prepared by the Federal Deposit Insurance Corp. Nationwide, home prices rose 6.7 percentage points faster than incomes during this period, according to the FDIC. "Income growth has not kept pace with home-price growth, and in recent years that gap has been widening," says Barbara Ryan, an associate director at the FDIC.

To be sure, housing prices could continue to climb, thanks in part to interest rates that are still at historically low levels. In addition, how much impact declining affordability will have depends in part on whether it's offset by shifting demographics and by rising employment -- which creates rising incomes -- says David Berson, chief economist of Fannie Mae. Another factor: what happens to demand from investors who tend to focus more on total return than on their monthly payments.

As affordability has declined, many borrowers have increased their buying power by shifting to adjustable-rate loans and interest-only mortgages, which allow borrowers to pay interest and no principal in the loan's early years. More recently, many have embraced option ARMs, which give borrowers multiple payment choices. Borrowers who elect to make the minimum payment can see their loan balance rise, which is known as "negative amortization."

"We postponed the inevitable with these interest-onlies and negative-amortization" loans, says David Lereah, chief economist of the National Association of Realtors. "But you can't sustain double-digit price appreciation and keep homes affordable."

So far, the steady upward appreciation in prices hasn't had much of an impact on home sales. In California, where affordability is a big problem, more-affordable areas are seeing bigger price gains. Home-price growth in San Diego and Orange County, two of California's least affordable markets, has dropped to the single digits, according to the California Association of Realtors, while prices have climbed more than 20 percent in less-expensive areas, such as Riverside-San Bernardino.

Overall, just 16 percent of households in California can afford the median-priced home, according to the California Association of Realtors, the lowest level since 1989, when the average rate on a 30-year fixed-rate mortgage was 10.33 percent. Rates on 30-year fixed-rate loans currently average just 5.81 percent, according to HSH Associates in Pompton Plains, N.J.